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The Transmission of Supply Shocks in Different Inflation Regimes

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  • Sarah Arndt
  • Zeno Enders

Abstract

We show that the impact of supply and monetary policy shocks on consumer prices is state-dependent. First, we let the data determine two inflation regimes and find that they are characterized by high and low inflation volatility. We then identify upstream supply shocks using instrumental variables based on data outliers in the producer price series. Such shocks exhibit a more substantial and more persistent effect on downstream prices during periods of elevated inflation volatility (State 2) compared to phases of more stable consumer price growth (State 1). Similarly, monetary policy shocks are more effective in State 2. Differenti-ating regimes by the level of inflation or the shock size does not reveal state dependency. The evidence supports a model in which producers optimally invest in price flexibility. This model predicts that stricter inflation targeting reduces price flexibility and, consequently, the pass-through of all shocks to inflation, beyond the standard demand channel.

Suggested Citation

  • Sarah Arndt & Zeno Enders, 2024. "The Transmission of Supply Shocks in Different Inflation Regimes," Working papers 938, Banque de France.
  • Handle: RePEc:bfr:banfra:938
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    Cited by:

    1. Khalil, Makram & Lewis, Vivien, 2024. "Product turnover and endogenous price flexibility in uncertain times," Discussion Papers 14/2024, Deutsche Bundesbank.

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    More about this item

    Keywords

    Inflation Regimes; Supply Shocks; Monetary Policy; Cost Pass-Through; Producer Prices;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles

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